Trade and globalization have become more inviting targets during
the current economic downturn. As output falls and unemployment
rises, politicians in Washington are questioning not only imports
but U.S. companies that invest in production abroad.

The incoming president, Barack Obama, pledged during his
campaign that, “Unlike John McCain, I will stop giving tax breaks
to corporations that ship jobs overseas and I will start giving
them to companies that create good jobs right here in
America.”1 That campaign refrain, echoed by a number of
other successful candidates, raises three basic questions:

Why do U.S. multinational companies establish affiliates abroad
and hire foreign workers? What kind of tax breaks are they
receiving? And should the new Congress and new president change
U.S. law to make it more difficult for U.S. multinational
corporations to produce goods and services in foreign
countries?

Reaching millions of new customers

To demonize U.S. multinationals operating production facilities
abroad is to indict virtually every major American company. At
latest count more than 2,500 U.S. corporations own and operate a
total of 23,853 affiliates in other countries. In 2006, according
to the U.S. Department of Commerce, majority-owned foreign
affiliates of U.S. companies posted $4.1 trillion in sales, created
just under $1 trillion in value added, employed 9.5 million foreign
workers, and earned $644 billion in net income for their U.S.-based
parent companies.2

The primary reason why U.S. companies invest in affiliates
abroad is to sell more products to foreign customers. Certain
services can only be delivered on the spot, where the provider must
have a physical presence in the same location as its customers.
Operating affiliates abroad allows U.S. companies to maintain
control over their brand name and intellectual property such as
trademarks, patents, and engineering expertise. U.S. companies also
establish foreign affiliates because of certain advantages in the
host country- lower-cost labor, ready access to raw materials and
other inputs, reduced transportation costs and proximity to their
ultimate customers. Yes, the motivations can include access to
“cheap labor,” but labor costs are not the principal motivation for
most U.S. direct investment abroad.

Politicians focus most of their attention on comparing exports
and imports, but the most common way American companies sell their
goods and services in the global market today is through overseas
affiliates. In 2006, U.S. multinational companies sold $3,301
billion in goods through their majority-owned affiliates abroad and
$677 billion in services. For every $1 billion in goods that U.S.
multinational companies exported from the United States in 2006,
those same companies sold $6.2 billion through their overseas
operations. For every $1 billion in service exports, U.S.- owned
affiliates abroad sold $1.6 billion.3

Contrary to popular myth, U.S. multinational companies do not
use their foreign operations as an “export platform” back to the
United States. Close to 90 percent of the goods and services
produced by U.S.-owned affiliates abroad are sold to customers
either in the host country or exported to consumers in third
countries outside the United States. Even in Mexico and China,
where low-wage workers are supposedly too poor to buy American
products, more than half of the products of new and existing U.S.
affiliates are sold in their domestic markets, whereas customers in
the United States account for only 17 percent of
sales.4

More Jobs Abroad, More Jobs at Home

Investing abroad is not about “shipping jobs overseas.” There is
no evidence that expanding employment at U.S.- owned affiliates
comes at the expense of overall employment by parent companies back
home in the United States. In fact, the evidence and experience of
U.S. multinational companies points in the opposite direction:
foreign and domestic operations tend to compliment each other and
expand together. A successful company operating in a favorable
business climate will tend to expand employment at both its
domestic and overseas operations. More activity and sales abroad
often require the hiring of more managers, accountants, lawyers,
engineers, and production workers at the parent company.

Consider Caterpillar Inc., the Peoria, Illinois-based company
known for making giant earth-moving equipment. From 2005 through
2007, the company enjoyed booming global sales because of strong
growth in overseas markets, especially those with resources
extracted from the ground. According to the company’s 2007 annual
report, Caterpillar earned 63 percent of its sales revenue abroad,
including $1 billion in sales in China alone. As a result,
Caterpillar ramped up employment at its overseas affiliates during
that time from 41,238 to 50,788, an increase of almost 10,000
workers. During that same three-year period, the company expanded
its domestic employment from 43,878 to 50,545, a healthy increase
of 6,667.5

Caterpillar’s experience is not unusual for U.S. multinational
companies. A 2005 study from the National Bureau of Economic
Research found that, during the 1980s and 1990s, there was “a
strong positive correlation between domestic and foreign growth
rates of multinational firms.” After analyzing the operations of
U.S. multinational companies at home and abroad, economists Mihir
A. Desai, C. Fritz Foley, and James R. Hines Jr. found that a 10
percent increase in capital investment in existing foreign
affiliates was associated with a 2.2 percent increase in domestic
investment by the same company and a 4 percent increase in
compensation for its domestic workforce. They also found a positive
connection between foreign and domestic sales, assets, and numbers
of employees.6 “Foreign production requires inputs of
tangible or intellectual property produced in the home country,”
the authors explained. “Greater foreign activity spurs higher
exports from American parent companies to foreign affiliates and
greater domestic R&D spending.”7

The positive connection between foreign and domestic employment
of U.S. multinational companies has continued into the current
decade. As Figure 1 shows, parent and affiliate employment have
tracked each other since the early 1980s. More recently, employment
rose briskly for parents and affiliates alike in the boom of the
late 1990s, fell for both during the downturn and slow recovery of
2001 through 2003, and then rose again from 2003 through
2006.8 Although the numbers have not been reported yet
for 2007 and 2008, it’s likely that the loss of net jobs in the
domestic U.S. economy will be mirrored by much slower growth or
outright decline in foreign affiliate employment.

Modest Investment in China and Mexico

Investment in China and Mexico drew the most fire on the
campaign trail. In a primary debate in Texas in February 2008,
then-senator Obama said, “In Youngstown, Ohio, I’ve talked to
workers who have seen their plants shipped overseas as a
consequence of bad trade deals like NAFTA, literally seeing
equipment unbolted from the floors of factories and shipped to
China.”9 That makes for a good sound-bite in the heat of
a campaign, but it does not accurately reflect the broader reality
of outward foreign investment by U.S. manufacturers.

Outflows of U.S. manufacturing investment to Mexico and China
have been modest by any measure. Between 2003 and 2007, U.S.
manufacturing companies sent an average of $2 billion a year in
direct investment to China and $1.9 billion to Mexico. That pales
in comparison to the average $22 billion a year in direct
manufacturing investment “shipped” to Europe during that same
period, but talking about equipment being unbolted from the floors
of U.S. factories and shipped to England just doesn’t have the same
bite.10 The modest annual outflow in investment to China
and Mexico is positively dwarfed by the annual $59 billion inflow
of manufacturing investment to the United States from abroad during
those same years11 and the average of $165 billion per
year that U.S. manufacturers invested domestically in plant and
equipment.12

The fear of manufacturing jobs being shipped to China and Mexico
is not supported by the evidence. While U.S. factories were
famously shedding those 3 million net jobs between 2000 and 2006,
U.S.-owned manufacturing affiliates abroad increased their
employment by a modest 128,000 jobs. An increase in 172,000 jobs at
U.S.-owned affiliates in China was partially offset by an actual
decline of almost 100,000 jobs at affiliates in
Mexico.13 The large majority of factory jobs lost in the
United States since 2000 were not “shipped to China” or anywhere
else, but were lost to automation and other sources of increased
efficiency in U.S. manufacturing.

U.S. manufacturing investment in China remains modest compared
to the huge political investment that candidates and pundits have
made in making it an issue. U.S. direct investment in China remains
a relatively small part of China’s overall economy, and a small
part of America’s total investments abroad. Of the nearly 10
million workers that U.S. affiliates employ abroad, fewer than 5
percent are Chinese; Americanowned affiliates employed just as many
manufacturing workers in high-wage Germany in 2006 as they did in
low-wage China.14

“Tax breaks” Keep U.S. Companies
Competitive

Politicians are not usually specific about exactly what “tax
breaks” they want to repeal. The biggest tax exemption for U.S.
companies that invest abroad is the deferral of tax payments for
“active” income. U.S. corporations are generally liable for tax on
their worldwide income, whether it is earned in the United States
or abroad. But the relatively high U.S. corporate tax rate is not
applied to income earned abroad that is reinvested abroad in
productive operations. U.S. multinationals are taxed on foreign
income only when they repatriate the earnings to the United States.
Not surprisingly, the deferral of active income gives U.S.
companies a powerful incentive to reinvest abroad what they earn
abroad, but this is hardly an incentive to “ship jobs
overseas.”

Such deferral may sound like an unjustified tax break to some,
but every major industrial country offers at least as favorable
treatment of foreign income to their multinational corporations.
Indeed, numerous major countries exempt their companies from paying
any tax on their foreign business operations. Foreign governments
seem to more readily grasp the fact that when corporations have
healthy and expanding foreign operations it is good for the parent
company and its workers back home.15

If President Obama and other leaders in Washington want to
encourage more investment in the United States, they should lower
the U.S. corporate tax rate, not seek to extend the high U.S. rate
to the overseas activities of U.S. companies. Extending high U.S.
tax rates to U.S.-owned affiliates abroad would put U.S. companies
at a competitive disadvantage as they try to compete to sell their
goods and services abroad. Their French and German competitors in
third-country markets would continue to pay the lower corporate tax
rates applied by the host country, while U.S. companies would be
burdened with paying the higher U.S. rate. The result of repealing
tax breaks on foreign earnings would be less investment in foreign
markets, lost sales, lower profits, and fewer employment and export
opportunities for parent companies back on American soil.

Politicians who disparage investment in foreign operations are
wedded to an outdated and misguided economic model that glorifies
domestic production for export above all other ways for Americans
to engage in the global economy. They would deny Americans access
to hundreds of millions of foreign customers and access to
lower-cost inputs through global supply chains. In short, they
would cripple American companies and their American workers as they
try to compete in global markets.